Exploring Models of Embedding Finance
Article 3 in 'The Transformative Potential of Embedded Finance'
From books such as Range and articles such as these, excellence across multiple fields is now considered the ultimate success - artists like A$AP Rocky, Beyonce and Kanye have cracked the fashion industry, whereas luminaries such as Virgil Abloh and Elon Musk have permeated culture from all angles. It's no wonder that the leading companies of our time aren’t satisfied with their fields and want to move into others, especially finance.
At first glance it may seem odd that the leading blue chips of our time are looking to further integrate themselves into our lives by providing financial offerings, but much like Bowie pushing the boundaries of fashion in the 80s, this is a pathway that has been trodden before. Today, however, that path is slightly less fraught with perils.
Before Apple and the iPhone wanted to help us with payments, one of the greatest US financial institutions in the late 90s and early 00s was to be found at the leading manufacturer of trains, airline engines and microwaves – General Electric. GE Capital was not only the cornerstone of Jack Welch’s empire, but powered the US economy, with their financial arm providing the whole gamut – from mortgages and credit cards to real estate and mutual fund investments. During its heyday it delivered consistent growth and cash flow to General Electric. However, following the Global Financial Crisis, GE Capital came to be a plague on the mothership, one that has lasted almost to this day.
Today, technology has changed the once highly capital-intensive path into offering financial services into one that has more vectors. In this article, we will analyse the three business models demonstrated in the below diagram that corporates can utilise to venture into embedded finance:
Model 1: Partnering with FinTechs (API-based Platforms)
In recent years, a slew of FinTechs have emerged that enable corporates to quickly and easily offer financial services. This business model provides connectivity between FinTechs and corporates. FinTechs have recognised the barriers corporates face in offering financial products and have begun to offer API-driven services such as bank accounts and lending services, credit and debit cards, payment processing services, etc. The below takes a deeper dive into a couple of these services:
API-led FinTechs like Green Dot offer bank accounts that allows corporates, such as CVS and Walmart, to leverage the customer data they possess to improve the loan underwriting process and monetise deposits via a recurring fee structure or interest on the account.
Stripe Capital’s end-to-end lending API allows corporates, like Jobber and Lightspeed, to lend capital to their business customers without the need to build their own solution, allowing the SMEs to obtain a quick cash injection. The advanced data analytics used by corporates identifies that a number of their SME clients have recurring cash flow problems. In response, they can rapidly integrate with Stripe Capital’s API to equip their platform with lending services, increasing flexibility in a world where customer demand (and problems) quickly changes.
Partnering with FinTechs permits corporates to experiment and develop their understanding of the financial industry, but also gives them a crucial advantage: greater command over their data. Corporates do not need to share their data with an FSI that can use the alternative datasets to improve their current (diminishing) market position and gain more insight into the way corporates use this data to analyse their customers. Corporates can also utilise the data insights they obtain about their customers’ engagement with the financial products offered to improve their offerings and create stickier, longer lasting client relationships.
Model 2: Finance in a Stack (White-Labeled Stacks)
A second manner in which financial services can be offered is by allowing FinTechs (and non-FinTechs) to offer finance as infrastructure, as white-labeled stacks to corporates who wish to embed financial services into their business models. Corporates can contract third-party FinTechs who build Infrastructure-as-a-Service platforms (like Finix for Payments Infrastructure-as-a-Service services) to embed financial products into their business and technology stacks and deliver a seamless experience to their customers. Here, the financial products offered are core to the suite of services offered by the corporate and enhance the value of the corporate’s primary offering.
The below diagram, taking the example of Shopify, illustrates how a ‘Finance in a Stack’ solution would work:
While Shopify started out as an enabler for SMEs and corporates to set up their online marketplaces, they have embraced the potential of financial services to offer all the tools that their clients could need to set up online businesses. Shop Pay, Shopify Balance and Shopify Capital are all part of Shopify’s ‘E-Commerce as a Service’ stack. This highlights the potential of corporates to offer similar services.
Facebook has also taken similar steps into offering a ‘Finance in a Stack’ solution. Facebook has a whole host of features they offer, ranging from their core social media platforms (Facebook and Instagram), to chat (WhatsApp, Messenger and Instagram Chat), Events, Marketplace, Facebook Platform, etc. As part of this core product stack, they have begun to offer SMEs a receivables financing program, where SMEs can sell unpaid invoices from any customer to Facebook. Their foray into financial services has also been headlined by Diem (formerly Libra), where they have partnered with 27 institutions to create single-currency stablecoins (USD, EUR, GBP) and a multi-currency coin (XDX). These coins can be used to transact via Facebook or the other institutions part of the Diem Association and can be converted into fiat currency on demand. As such, Facebook is aiming to make payments a key part of its offerings to customers, with the payments and receivables financing functionalities both augmenting and forming part of Facebook’s core services.
As corporates get more experienced in offering financial services, the volume of transactions on their platforms will increase. On the one hand, if they have been embedding finance via integrations with API-led platforms offered by FinTechs (Model 1), the dependence on external platforms could hinder their ability to fully control their own financial stack. On the other hand, if they have been offering financial services by partnering with FSIs (Model 3), they would not be able to capture the full financial benefits of the increased activity since the financial services would be underwritten by their partner banks. Finance in a Stack is the beginning of an investment-heavy strategic journey that can further enhance the stickiness of their ecosystem.
Model 3: Partnering with Financial Services Institutions (BaaS Models)
A final way in which corporates can offer embedded financing is by partnering with financial services institutions (banks or insurers). This model creates an integrated ecosystem by connecting all stakeholders and using the stature of the partner institutions to build consumer trust across the board. Uber’s ecosystem, for instance, extends beyond drivers and riders to the car manufacturers who lease the vehicles to drivers, destination owners who share data, and other companies who offer coupons and deals through commercial partnerships.
The FSIs can provide the ‘plumbing’ for the financial services offered by the corporate – a clear example is Apple Card, a joint credit card delivered by Apple, Goldman Sachs and Mastercard. The card provides a seamless® experience for Apple customers, who can sign up for the Apple Card via the Wallet app. Some financial services offered through Apple Card include a 3% cashback on Apple Card purchases using Apple; the ability to buy Apple products by paying monthly and interest-free at 0% APR (a form of Buy Now, Pay Later service) and available credit depending on the credit score. This is a variant of Banking as a Service (BaaS), where Apple has picked and chosen specific financial services to embed into its customer experience.
Partnering with FSIs enables corporates to enter the financial services space in a deliberate manner, navigating some of the obstacles prevalent in Finance.
They would not need to obtain a license or go through costly and time-consuming regulatory approvals which can hinder the speed at which they can improve their customer experience. Diem comes into mind again, where the project received immediate and significant regulatory blowback when it was announced. Facebook was forced to scale back its ambition, re-brand the project from Libra to Diem, and delay its launch date.
They can gain business, regulatory and technological experience in financial services while learning the ins and outs of the business and improve the brand image of the financial products they provide. Amazon partnering with Goldman Sachs to offer credit lines to sellers on their platform illustrates this. Amazon Lending has received criticism for not understanding credit risk correctly, and being over-reliant on the data it obtains about customers from its platform. Partnering with Goldman Sachs gives Amazon the expertise to learn more about credit risk assessment and expand its SME lending presence without any significant financial or regulatory costs.
FSIs, on the other hand, have significant near-term advantages from partnering with corporates:
Amazon was responsible for 30.1% of UK e-commerce spending in 2019 and has 2.3 million active sellers worldwide. Banks like HSBC and Santander, on the other hand, are getting overtaken by start-ups like iwoca in the SME market in the UK. Partnering with corporates like Amazon would enable these banks to gain access to a huge B2B and B2C user base to provide financial services to. This can broaden their loan books by serving and creating longer-term relationships with clients who they could not access previously.
Most traditional lenders still use traditional credit scoring models. They are facing a widening ‘data gap’ between them and their plucky (and dangerous) competitors like Ant Financial who, prior to their enforced downsizing, utilised more than 3,000 variables in their credit risk models. Through partnerships, FSIs will be armed with the alternative datasets from the corporates’ platforms that can enable them to improve their credit decisioning and customer profiles, bridge this yawning data gap and thus fix issues in their customer engagement strategy.
On the whole, partnering with FSIs is the least risky business model via which corporates can delve into the embedded financing space since the financial exposure for any products offered is undertaken by the partner banks. The trade-off is that the financial returns corporates make from providing these services will be lower. This model may not necessarily be a model that they will adopt in the longer term and could switch to either partnering with FinTechs or build finance into their stacks to gain more control of the financial services they provide to their customers.
Embedding Financial Products, the Correct Way
In order to take full advantage of the vast potential of embedded finance, corporates must:
Offer Products via the Most Appropriate Business Model at the Correct Time: Corporates cannot begin their journey into embedded finance via Model 2 (Finance-in-a-Stack); they will face teething issues and will not have the requisite financial or technology experience to tackle a myriad of issues early on. As such, it is vital to deploy the correct business model at the correct time.
Play by the Rules of Financial Regulators: The Move Fast and Break Things mantra does not apply to financial regulators. Practices that have served many leading companies to date like moving and dominating markets at pace and innovations that push the boundaries of regulations do not hold in the world of finance. Activities are highly scrutinised by investors and regulators, which can stop an initiative dead like Facebook’s Libra, or as Jack Ma found with Ant Financial. For corporates to succeed in this world they have to play by the rules of the regulators, and ensure that they are onside before they hope to change the rules.
Choose Financial Products that are Most Relevant for their Customers. There are a significant number of financial products that corporates can offer. To grow quickly, they must identify and prioritise the products that best meet their customers’ needs. If most of their customers are cash-rich, for example, it would not make sense to embed lending products to offer to their customers.
In our next article, we will delve into the various financial products that corporates are currently embedding into their offerings.
Related Reading
Range by David Epstein
Doing Digital: Lessons from Leaders by Chris Skinner
The Upstarts by Brad Stone
The Space Barons by Christian Davenport
Articles in this Series
Article 1: The Rise of Embedded Finance
Article 2:The Perfect Storm
Article 4: Embedded Everything
Article 5: The Evolution of Embedded Finance
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